This site is operated by a business or businesses owned by Informa PLC and all copyright resides with them. Informa PLC's registered office is 5 Howick Place, London SW1P 1WG. Registered in England and Wales. Number 8860726.

Markets volatile with influence of index funds and biofuels

The grain and livestock industries have experienced a certain change in attitude since USDA's late January crop report.

Several weeks ago, agriculture economist Richard Brock was at a conference with a professor from Kansas State University who “… indicated that currently in Kansas there's such a quick liquidation that there's a three-year wait to get slaughter space for sows.

“There is a wait list, but I don't think it's three years. In Illinois, we're seeing a lot of 1,000- to 1,300-sow units being liquidated,” said Brock, author of the Brock Report and contributor to Delta Farm Press, at Arkansas State University's Agribusiness Conference in Jonesboro, Ark., on Feb. 13.

Regardless, if the corn market isn't corrected soon, “frankly there will be irreparable damage in the pork industry. Pork prices will be absolutely through the roof in 12 to 18 months.”

As for problems the poultry industry is having, it was announced in early February prices for chicken breasts are set to rise 7 to 10 percent. “We're seeing probably a cutback in poultry for the first time since I've been in business over 30 years. So there are repercussions from this strong grain market and changing world.”

In the grain elevator business, “the last three weeks have been the most chaotic I've ever seen. A week ago, I was speaking at the Minnesota Feed and Grain Convention. I had dinner with a banker from a large, national bank the night before. Just (days) before they'd notified some of their clients, independent grain elevator operators, not to come back for additional lines of credit.”

There are “huge problems” in the grain elevator business. “If they can't increase a line of credit, they must liquidate their position. That means an increasingly wide basis.”

Further, a large, regional Midwest elevator company announced two weeks it wouldn't even make bids for new-crop soybeans, wheat or corn. A farmer in that region “can't even get a price, right now. These are some of the issues the industry as a whole will be facing.”

Economic rules

While studying agriculture economics at Purdue University, one of Brock's professors said, “the laws of economics have never been repealed and probably never will be. If you keep the price of any commodity too high, too long, someone will find a way to produce more of it, use less of it or use something else.”

Brock finds that “particularly true of the energy market, right now. We've kept prices much too high for way too long. We don't have a shortage of energy, of crude oil. We have a perceived shortage of crude oil.

“The only time we've had a real energy shortage was in 1973. That's the only time I can remember lines at gas stations because of shortages.”

What is happening now is a huge change in technology. For example, China has eight nuclear plants under construction with 45 others on the drawing board.

Few are aware that within the next 18 months, six nuclear plants will start up in the United States, the first built in the country since the frightening Three-Mile Island incident in 1979. Meanwhile, “if you drive through the Midwest, you can't go 10 miles without seeing windmill farms. They're going up everywhere.”

Regarding the value of the U.S. dollar, Brock takes a position contrary to many agriculture economists. “I don't understand why a lot of the press and ag economists have convinced producers that a cheap dollar is good for us. I think — particularly if you're a corn or soybean farmer — a cheap dollar hurts more than helps.”

The value of the dollar is a relative issue. “We don't compete against anyone in the corn market so what difference does the value of the dollar make? We're the majority of the world's corn export market. We have no significant competition.”

Last year, the United States exported more corn at $4.50 than it did two years ago at $2. Is there any correlation between the value of the dollar and price of corn? “Countries buy corn based on need not price.”

What about soybeans U.S. farmers are competing against in South America? “Again, show me a correlation between the value of our currency and Brazil's and soybean exports. My guess is you'd find a much stronger correlation between ocean freight rates and soybean exports.”

Fifty percent of the nitrogen used in U.S. agriculture is now imported along with 80 percent of the potash. What has really happened “is the value of the dollar has substantially increased the price of our inputs. And I'd argue it has helped the selling price not at all. Yet, for some reason, we're led to believe the (lower) value of the dollar is good for us.”

Very few are aware one of the biggest issues impacting U.S. agriculture are index funds.

“There are two commodity funds. Regular funds can be both long and short. In 2002, those had about $51 billion in. By last September, the most recent data, that number had risen to about $185 billion.”

The real issue, though, is with index funds. “The granddaddy of them is the Goldman and Sachs Index Fund. Our last estimate was it had $103 billion.”

Three or four years ago, any fund that traded commodities was subject to position limits. Suppose the position limit on corn was around 18 million bushels. “If you're a manager of a Goldman Sachs fund and the market moves $1, that's (potentially) $18 million dollars. That's a lot of money to us but if you're working with $103 billion, it's a pimple on an elephant's back.”

So the index funds petitioned the Commodity Futures Trading Commission (CFTC) to be classified as commercial companies. The limits on a commercial company like ADM or Cargill are only the amounts of grain being sold or bought.

Meanwhile, the index fund companies don't have any grain, only cash. Their only limit is the amount of money on hand. This allows them to go long on as much corn, beans, wheat and crude oil as they have cash.

There are smaller index funds “and they all have perspectives and must maintain balances at the end of each month. For the Goldman Sachs fund, 74 percent of its money must be invested in the energy market. In other words, the fund has $75 billion to be used in crude oil and gas futures. Further, 8.2 percent of its money must be traded in grain markets.

“Think about this, the fund has $8.5 billion for corn, soybeans and wheat and $74 billion for crude oil and heating oil. I never thought I'd be considering a conspiracy theory. But I can see a novel being written in about five years as to where the money was coming from for these funds. Wouldn't it be ironic if we discovered that of that $103 billion, a lot is oil money from the Middle East. And the fund is self-perpetuating: put the money in the fund, they have unlimited access to buying oil futures to keep the price of oil up and keep the flow of money going. I'm not saying that's happening, but I've seen stranger things.”

What does worry Brock is that, as of a month ago, the index funds position in Chicago on soft red winter wheat represented 270 percent of the crop.

“That was the position! People wonder why the wheat market is so volatile — because the funds are buying more wheat than we produce. In the corn market, (the funds) represent only about 15 percent of the crop. They actually have a current position in cotton of over 50 percent of the crop.”

The largest long position is held by the index funds — currently long on about 400,000 corn contracts. “That's 2 billion bushels of corn. The regular funds are long on another 100,000 contracts. So, between the two types of funds, they're long on over 3 billion bushels of corn.”

Brock is unsure of a solution. However, the livestock and poultry industries are “all over” the CFTC to get regulations changed.

The index funds distort the market, insists Brock. With such a high futures market, “the cash can't keep up. There are basis swings like we've never seen before because the grain elevators can't meet margin calls.

“The one thing that could happen is — and let's use the Goldman Sachs fund as an example — if, hypothetically, crude oil dropped $15 a barrel. At the end of the month, the fund must adjust assets.” If all other commodities stay the same and no other cash flow is coming into the fund, “they'll have to sell corn, soybeans, wheat and cotton in order to bring their percentages back in line.

“If they have more money coming into their fund, though, instead of selling corn, beans, wheat and cotton they could buy more energy to maintain the monthly balances.”

Fuel

Currently, there are 127 U.S. ethanol plants with an average capacity of 59 million gallons. There are 68 facilities under construction with an average capacity of 84 million gallons. Another 88 facilities are on the drawing board with over 89 million gallons of capacity.

“If you take a look at the mandate in the energy bill that just passed, 36 billion gallons of ethanol (are required) by 2015 and 15 billion of that is to come from corn.… In 12 to 18 months, we'll already be producing enough ethanol with what's already under construction to reach the 2015 mandate.”

If the plants proposed are built, by 2015 the United States will produce about 22 billion ethanol. “But I don't think we'll get there because of what's happened in the last month. By year's end, in Illinois 22 percent of the corn crop will be used for ethanol. In Indiana 41 percent, Iowa 53 percent, Kansas 38 percent, Kentucky 8 percent, Nebraska 40 percent, North Dakota 45 percent, South Dakota 58 percent.

Ohio — which a year ago was at zero — will be at 35 percent. Ohio has always been a corn-deficit state because it ships corn east and southeast to pork and poultry industries. Here they are, already in a corn deficit, and now 35 percent of their crop will be in an ethanol plant. That doesn't make a lot of sense, but it's being done.”

With current corn prices, some ethanol plants are losing money. “I received an e-mail last night from the president of a feed company in California. He named three (plants) that are under construction and have stopped building and six plants that were on the drawing board and (have been dropped).

“I think what the industry will find is if the corn market stays high much longer, a lot of the plants being planned will disappear. We won't reach the big (predictions) made.

“This industry has changed enormously in just the last six weeks. The economics have changed because of the price of corn.”

Another issue in California is almost all of the corn used for ethanol is coming from Nebraska, South Dakota and Minnesota.

This year, there's plenty of corn. However, next year is a concern.

“Corn can be found, but as anyone in the railroad industry knows, the problem is there aren't enough railcars to get it from the western Corn Belt to California. And even if you could get the railcars, there isn't enough track. It isn't like building a new track through Arkansas — there are these things called the Rocky Mountains that aren't flat. Getting new track built won't happen.”

Ethanol is about $2.20 per gallon. That means using a break-even formula, $6 corn is required. In California, by the time “they pay about $1.40 per bushel to get the corn from the western Corn Belt the price (is too high). That's why some plants are shutting down.”

Brock estimates that about 3.2 billion corn bushels from this year's crop will go to ethanol. Next year, he says, the number will be between 3.8 billion and 4 billion.

A possible bearish factor to add to the mix: the 54-cent tariff on imported ethanol expires in 11 months.

“If you'd asked me three months ago about the chances of that being renewed, I'd have said 95 percent. But with political pressure in Washington, D.C., right now, I'm not so sure it'll be renewed. It's up in the air and might depend on who the next president is.”

The next thing that could change things around is genetic improvements. “Talk to executives at Pioneer and Monsanto and they'll say a 10-bushel-per-acre increase in the next two years is inevitable. Most are more optimistic than that. Add 10 bushels to the corn yield and it would solve a lot of problems. We'd have corn running out of our ears.”

Two weeks ago, Brock made a mistake while giving a speech. “I said someone would be coming along with an enzyme that would allow poultry and pork to digest more than the 10 percent of DDG (Dry Distillers Grain) equivalent in their rations.”

As soon as the speech was over, “some executives (approached me and explained) they'd released a product called Allzyme SSF about a month ago. This is being commercially marketed to the poultry and pork companies. If (it works), this would change the demand for corn quite a bit. DDG could be fed more aggressively to poultry.”